Milton Friedman vs. the Fed

The Nobel laureate would never have endorsed increasing inflation to stimulate the economy.

By ALLAN H. MELTZER

“…Friedman’s main message for central banks was to maintain a monetary rule that kept the growth of the money supply constant. In his Newsweek column, “Inflation and Jobs” (Nov. 12, 1979), for example, Friedman emphasized that “unemployment is . . . a side effect of the cure for inflation,” so that if a central bank “cured” unemployment by inflating, it “will have unemployment later.” In other words, don’t try it.

Friedman’s Newsweek column for July 28, 1980 (“Improving Monetary Policy”) came with the unemployment rate rising past 7%. His proposals for improving policy made no mention of using monetary expansion to reduce unemployment. He proposed rules for stable growth to achieve target “dollar levels of monetary aggregates.”

Friedman served on President Reagan’s economic policy advisory board. His memos on monetary policy repeat the themes he made familiar to Newsweek readers and others all over the world. There is not a word suggesting that monetary policy should try to raise the inflation rate in order to reduce the unemployment rate.

This is unsurprising, as he had explained many times in the past that any such reduction would be temporary and last only until people caught on to the higher inflation. At that point, they would demand higher wages and interest rates.

Friedman made an exception to his rule about steady-state monetary policy in case of deflation. When prices fell, as they had during the Great Depression or in Japan in the 1990s, he urged the central bank to increase money growth. I served as one of two honorary advisers to the Bank of Japan in the 1990s. With short-term rates close to zero, I gave the same advice, urging the bank several times to buy long-term bonds or foreign exchange to increase money growth until deflation ended.

All this is not relevant now, since there is no sign of deflation in the United States. The Fed’s claim that there is a risk of deflation should embarrass it. …”

Ben Bernanke’s Impossible Dream

The Fed’s reckless notion that it can simultaneously raise inflation and lower interest rates presumes bond buyers are fools. They aren’t.

By ALAN REYNOLDS

“…Federal Reserve Chairman Ben Bernanke may be an excellent economist, but he is not a very good bond salesman. Since his Aug. 27 speech at an annual Fed symposium in Jackson Hole, Wyo., he’s been telling us that he thinks inflation is too low and long-term interest rates are too high. In a quixotic effort to “maximize employment,” he’s begun purchasing up to $600 billion worth of long-term Treasury obligations to push inflation up and bond yields down.

If it worked as planned, this would flatten the yield curve, meaning it would narrow the spread between short-term and long-term interest rates. Since banks make money by borrowing short and lending long, the effect would be to discourage bank lending. That seems an unpromising way to stimulate the economy. But the whole notion of simultaneously raising inflation and lowering bond yields presumes bond buyers are docile fools. …”

“…The University of Michigan survey of expected inflation has hovered around 2.7%-3.2% since the recovery began last July, aside from two low readings of 2.2% in September 2009 and September 2010. That measure of inflation expectations has been higher than it was in November 2002, when then-Fed Governor Bernanke first began fretting about “deflation.” But inflation expectations are still not high enough to please the Fed chairman.

Domestic and foreign investors have reacted to the Fed’s plans by driving the dollar way down and commodity prices way up, which is consistent with higher expected inflation. So too is the gap between yields on regular Treasury bonds and the inflation-protected variety (TIPS), which has widened by more than 60 basis points since late August. …”

The Power of Choice – Milton Friedman

Inside Look: Managing the Credit Crisis (Part 2)

Inside Look – Inflation Threat Looming? – Bloomberg

Allan H. Meltzer

“…Allan H. Meltzer is an American economist and professor of Political Economy at Carnegie Mellon University’s Tepper School of Business in Pittsburgh, Pennsylvania[1]. He was born February 6, 1928, in Boston, Massachusetts. He is the author of dozens of academic papers and books on monetary policy and the Federal Reserve Bank, and is considered one of the world’s foremost experts on the development and applications of monetary policy[2]. His book A History of the Federal Reserve is considered the most comprehensive history of the central bank.[3] Volume II of his History of the Federal Reserve Bank, which covers the years since the Federal Reserve accord in 1951 to 1969, was released in February, 2010.[4] Meltzer is considered to have originated the aphorism, “Capitalism without failure is like religion without sin. It doesn’t work.”[5] …”